Exchange Traded Debt: Income For The Yield-Starved - Part II, The Post-Brexit Edition

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Includes: ABR, ARCC, COWN, DUK, EBAY, GE, GS, HCAP, HRZN, HTGC, KKR, MAIN, NS, PBI, PSEC, SALT, SBLK, SO, SSW, STNG, SWK, TCAP, TCRD, TPVG, VTR, VZ
by: David L. Powell

Summary

We continue our examination of the potential profits and pitfalls of investing in short maturity Exchange Traded Debt in a continually turbulent financial world.

We derive three additional screens - the Lookback, the Relative Strength and the Multimode Relative Strength to further examine the Universe of potential ETD issues.

We aggregate the screens from both parts of this article to suggest high potential alternatives.

We examine a snapshot of post-BREXIT fallout to understand ETD performance vs. the conventional "Flight to Quality" alternatives.

Introduction

In Part I of this article, we briefly examined the issuance of long maturity Exchange Traded Debt (ETD) by "name brand credits" such as Duke Energy (DUK), Nustar (NS), Pitney Bowes (PBI), Southern Company (SO), Stanley Black & Decker (SWK), Verizon (VZ); Goldman Sachs (GS), KKR & Co. (NYSE:KKR), GE Capital (GE), Ventas (VTR) and eBay (EBAY). We then transitioned the focus of the article to short maturity ETD issued by the various shipping companies [e.g. Seaspan (SSW), Star Bulk Carriers (SBLK), Scorpio Bulkers (SALT) and Scorpio Tankers (STNG)] and various "nextgen financials" e.g. Ares Capital (ARCC), Harvest Capital (HCAP), Hercules Capital (HTGC), Horizon Technology (HRZN), TriplePoint Ventures (TPVG), Triangle Capital (TCAP), THL Credit (TCRD), Main Street (MAIN), Arbor Realty (ABR) and Cowen Group (COWN). I then focused on the income potential of short maturity ETD based on the results of two screens: the substantial price decrease screen and the downturn price resilience screen.

In this part of the article, I will formulate and examine the results from several additional screens: the Lookback Screen, the Relative Strength Screen and the Multimode Relative Strength screen to further analyze the universe of interest. Based on the aggregated results of these screens, I then derive a small universe of interest for further detailed research. Finally, the recent BREXIT event gave us at least a snapshot opportunity to examine the performance of ETD issues during financial turbulence and to compare these results with common "flight to quality" destination bonds and bond funds as key bond yields plumbed even lower depths led by the 10 year German Bund (-0.10%), the 10 year Japanese Government Bond (-0.20%) and the 10 year US Treasury (1.46%).

Lookback Screen

Our first additional screen was designed to provide a historical lookback at issuance by the companies of interest universe resulting from the short maturity ETD issues discussed in the first part of this article. We increased the maturity constraint beyond the year 2028 to include the years 2029 and 2030. This screen resulted in the table below, largely sorted by original issuance date. The "lookback" screen also picks up issues that have already been called (highlighted in Yellow bold/italics).

Click to enlarge

One of the alleged benefits of short maturity ETD from this Universe of companies is the lack of defaults. But a close look at this table tells a slightly different story. Only one of these companies issued ETD in 2010 and all of the other debt was issued in 2012 or later. None of these companies had previous ETD issues. The conclusion is that perhaps part of the driver for lack of default history is the lack of issuance history. The ETD resulting from this screen is almost entirely of recent vintage!

Relative Strength Screening

After further examining the data resulting from writing Part I of this article, I decided to explore a different screen - namely one that might help derive a view of what I would call "relative strength". I screened for issues with maturities out to 2030, coupon rates greater than 5% and limited to companies from the Universe above that had sold multiple ETD issues. I then took the results from this screen and looked for three characteristics:

· signs of relative strength - e.g. a serial issuer who was able to come to market with successively larger issues at comparable or lower interest rates or an issuer who was able to retire existing debt with new debt issuance at lower rates

· signs of relative weakness - e.g. an issuer needed to offer higher interest rates in order to float subsequent issues

· signs of relative stability - e.g. an issuer could bring additional debt to market at rates comparable to the rates associated with existing debt

Ts screen resulted in the creation of the table depicted below:

Click to enlarge

Examples of relative strength are: (1) Ares was able to retire relatively expensive debt early and replace it with considerably more cost effective debt; (2) SOHO was able to float an additional issue on significantly better terms; (3) Triangle Capital was able to float additional offerings and retire higher priced debt and (4) the likes of Hercules and Newtek were able to float larger offerings at substantially lower interest rates. Examples of stability were: (1) Travel Centers was able to float serial large issues on very similar terms and (2) THL Credit floating additional offerings on the same terms. Of course this line of reasoning has to be backed up by real credit analysis. Take the example of Prospect Capital (NASDAQ:PSEC). Prospect floated a very large 2nd offering on more favorable terms and retired more expensive debt. However, this offering (PBB) was a prominent "victim" of the early 2016 meltdown as shown in Part I of this article.

Multimode Relative Strength Screen

I created an additional screen that replaced the constraint above of multiple ETD issues with the constraint of multiple ETD or preferred stock issuance. The reasoning is that a particular company has multiple financing options and as we have seen from the lookback screen above, the use of ETD is often a recent addition to the fund raising "toolbag". For example, Arbor Realty (NYSE:ABR) would not qualify for the previous screen but has one ETD issue - ABRN and several high yield Preferred issues: ABRpfA, ABRpfB and ABRpfC. Similarly, the largest single ETD issue by companies in our Universe of interest was done by Seaspan. Seaspan would also not qualify for the previous screen but gets picked up here due to its serial issuance of preferred stock. Note the most preferred stocks are "perpetual" - i.e. there is no mandatory call date (and thus we should expect investors to demand higher rates). These are designated with a (P) in the table below. There are a number of preferred stocks that are known as "Term Preferred" that have mandatory call dates. These are designated with a (TP) in the table below.

Click to enlargeThis screen yields an example of the "signs of weakness" we discussed above - namely RAIT Financial. RAIT has 3 Preferreds, all issued 10 or more years ago with high coupons. It has floated several newer ETD issues yet failed to retire any of the more expensive Preferreds that were callable as early as 2009.

Another interesting case is that of Seaspan (NYSE:SSW). Seaspan has only one ETD issue (SSWN) but it is notable due to the sheer size - $300M. I consider SSWN to be of particular interest because it is NOT callable early. Seaspan is also interesting because of its serial issuance of large preferred offerings despite the considerable headwinds buffeting the shipping industry. My analysis of this aggregate information is that it captures "signs of stability".

Weathering Storms

One of the initial purposes of this article was to examine the question of the seeming high yields from ETD turning into a mirage due to financial turbulence. One test played out in early 2016 as many issues plummeted (see the table in Part I of this article). It so happens that I am writing this article on Saturday 6/25/16 so we have another datapoint - namely the one day snapshot of BREXIT fallout. As a point of comparison consider the performance of various treasury, corporate and MUNI Bond funds and closed end funds on 6/24/16.

Click to enlarge I don't know of any ETD index that would cover the Universe of interest in this article so instead I created a table of 1-day performance of ETD issues of interest and calculated the one-day change for each issue.

Click to enlargeThe resulting average change was -0.13%. Not a bad performance on a day when many major averages were down more than 3% but perhaps not a sturdy beneficiary of "flight to safety".

Odds and Ends

Finally, the multimode screen above led us to mention an area of ideas somewhat similar to ETD - namely the so-called term preferreds. A full exploration of this path would take another article but it is worth a few sentences here to explore the most similar issues to our ETD universe. I screened for those with short mandatory maturities and coupons greater than 5%, issued by closely adjacent firms. This screen yields the candidates in the table below:

Click to enlarge Finally, the short maturity ETD issues that emerge based on the aggregation of various screening criteria explored in Part I and Part II are listed in the Table below. Note that I included RFTA despite relative weakness in RAIT Financial due to its nearby maturity. I also excluded issues from the shipping industry due to the obvious financial turbulence that has engulfed the industry. The exception was SSWN which strikes me as highly attractive due to its short maturity, relative strength and absence of early callability. No doubt many readers would find shipping to be a potential rich source of opportunity - I suggest looking deeply into the underlying financials and prospects before proceeding. As always, I would prefer to pick up these issues at or below par value - but note that all of them are not immediately callable hence you should not be fixated on purchasing at par vs. purchasing at a price like $25.03. I would also note that several ETD issues are rather thinly traded and have particular trading patterns (e.g. weak in the morning, strong at the close) that I won't explore further in this article.

Click to enlargeConclusions

ETD, especially shorter duration ETD, offers an interesting set of possibilities in our current environment of a sideways (or maybe downward moving) stock market and persistently low interest rates on "flight to quality" debt vehicles. We explored a number of screens in Part I and Part II of this article and aggregated the results to select a small set of candidate possibilities for further research/due diligence. We examined the history of defaults and early calls on this set of securities. Finally, we briefly examined the impact of a particularly turbulent financial event - namely BREXIT on this class of securities. Short maturity ETD held up well but obviously one day does not constitute real evidence/trends. The other key looming issue from our screens is that most of the resulting universe remains clustered in essentially one industry - this feels worrisome to me...

Disclosure: I am/we are long ABRN, TANO, TANN, ARU, HCAPL, HCJ. SSWN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not an investment advisor, I am not giving you (the reader) investment advice. I strongly encourage you to pursue due diligence.